Global Perspectives & Local Lenses
Investing in international markets feels more complicated than ever in today’s environment. With inflationary pressures hampering economic growth, a war in Eastern Europe and higher energy prices impacting consumers and businesses alike, market volatility has been on the rise. How do investors stay the course when investing across the globe?
Our international research analysts share their insights along with some of the dynamics that are shaping investment opportunities across the globe.
Chris Piel, CFA: In non-US markets, complexity has certainly ratcheted up over the past couple of years in terms of the macroenvironment. In addition to the factors mentioned, the COVID pandemic has also hit countries in different ways and each market or economy is now recovering at its own unique pace as policy restrictions ease. As bottom-up investors, we try to remain focused on estimating the long-term intrinsic value of a business based on its normalized, through-cycle earnings power; but at the same time, we have to make sure that we are capturing and properly accounting for the unique risks associated with a specific geographic location.
The Chinese regulatory environment, for example, has been front and center in the media recently and provides a good illustration of the unique regulatory risks that are present in China. China’s one-party governmental system allows the country to move quickly and implement swift regulatory and policy changes at scale, which is unique to other markets globally. We’ve seen this in the education sector, in real estate and most recently, in the technology space. The impact that these regulations have on Chinese business valuations is felt swiftly, compared to developed markets, for example, where you typically have a two-party governmental system that tends to implement sweeping policy changes only gradually over time, in a slower, less onerous manner.
We own Chinese technology and entertainment conglomerate Tencent Holdings, for example, which has come under regulatory pressure in the technology space. As we continue to evaluate our long-term investment in Tencent, we want to make sure that we are pricing in the risk of this increased regulatory pressure accurately. There are a lot of ways that we can do this. For one, the discount rate used to translate Tencent’s future cash flows back into today’s dollars will likely be higher than it would be otherwise for a similar business in another market where the regulatory risk may be less onerous. At the same time, we may adjust our growth estimates lower, which could then, ultimately, impact our normalized margin assumptions. All these factors then roll-up into the multiple that we believe is fair and would be willing to pay for a business that is subject to these conditions. After taking all of this into consideration, if the current market price is still below what we think the business is worth with these risks incorporated, and there is a wide enough margin of safety (our estimate of intrinsic value minus the current market price), then we believe these types of situations can represent attractive long-term investment opportunities.
Yiting Liu, CFA: Another consideration for investors in non-US markets is whether a company operates locally, regionally or globally. For example, luxury goods such as those sold by LVMH or Richemont, are sold to customers worldwide. So, the location of these companies’ headquarters is less relevant as these businesses compete in the same product categories as other global consumer goods companies. Therefore, our evaluation is based on the nature of the global luxury goods sector, not necessarily on the local market dynamics. In contrast, we also invest in businesses that are more idiosyncratic or regional. For example, we own a Peruvian bank called Credicorp, and the nature of its business has very little to do with banks in other countries/regions. Credicorp is subject to its own business cycle as well as the economic cycle, interest rates and credit cycle of Peru.
This is part of what makes investing in non-US businesses so exciting. Businesses are so diverse and unique across the globe that at any given point in time there is always a country, sector, industry or company that is experiencing some kind of market dislocation for investors to capitalize on. It’s a matter of determining whether those market dislocations are justified or not. If we believe the risk-reward balance is attractive, then that business may be a potential investment opportunity.
Chendhore Veerappan, PhD, CFA: In terms of idiosyncratic opportunities, health care is a prime area to find interesting investment ideas given its diverse nature. It’s difficult to compare large pharmaceutical companies or large device companies because each business has unique products, unique patent cycles and different end markets, each with their own embedded risks. The variables that drive the valuation of these businesses differ depending on the unique situation of a given asset (e.g., drug or device).
The type of health care system can also meaningfully impact the valuation of a business. For example, many countries have public health care systems — in these markets, public spending levels are an appropriate risk consideration. In other countries, especially emerging markets, insurance does not pay for generic drugs at the pharmacy. In these situations, it's about income growth not public spending. In other markets, like the US, where health care is largely privatized, a more meaningful risk consideration is consumer- and payer-led health care spending.
There can also be binary risks that we need to understand in order to assess the long-term potential outcomes. For example, China recently instituted what it calls a volume-based procurement system for pharmaceuticals in which the government decides who the supplier should be of a particular drug, and that supplier will own the majority of the market. Prior to this, China’s drug market was largely a free, open market where competitors could negotiate individually in each province and build their own market presence. As Chris mentioned, changes like this can be swift, so China’s pharmaceutical market basically changed overnight. And the risk for pharma companies operating in China has thus changed dramatically.
As you look at different companies across the world, there are all types of idiosyncratic risks. Our goal is to embed these risks into our intrinsic value estimates, reflecting them in our pricing and margin assumptions and our required rates of return.
As of 31 August 2022, Diamond Hill owned shares of Tencent Holdings Ltd, LVMH Moet Hennessy Louis Vuitton SE, Compagnie Financiere Richemont SA and Credicorp Ltd.
The views expressed are those of the authors as of September 2022 and are subject to change without notice. These opinions are not intended to be a forecast of future events, a guarantee of future results or investment advice. Investing involves risk, including the possible loss of principal. Past performance is not a guarantee of future results.